3 Reasons To Own Signet Jewelers

Signet Jewelers (NYSE:SIG), operator of Kay Jewelers in the United States and H. Samuel in the United Kingdom, announces earnings on March 22 and they're expected to be an all-time high. Good things are happening in the jewelry business these days and as a result its stock is pushing towards $50, a level it's reached only once before in May 2007.

It's been a wild ride for Signet's stock since hitting the $50 mark in 2007. Almost immediately upon reaching said high, its stock began plummeting back to earth. By the market lows of early 2009, it had fallen to $7. Three years and 600% later, its stock closed on March 12 trading at $48.87, a scant $1.13 from the elusive $50 mark and its highest level since September 2008, when it went from being an American Depository Receipt to a full-fledged New York Stock Exchange stock. As part of its move from the London Stock Exchange, its shares did a reverse split on a one-for-twenty basis. At the time of the split, they traded around $23, so the net result has been a good one for shareholders. For related reading, see Understanding Stock Splits.

Profitability

As I said in the opening paragraph, good things are happening in the jewelry business. Signet expects a minimum diluted earnings per share for fiscal 2012 of $3.67. That puts its net income at $320 million, higher than it's ever been on $3.76 billion in revenue, also a record. In 2012, management had four financial objectives: improve its gross margin, maintain selling, general and administrative expenses similar to fiscal 2011, capital expenditures between $110 million and $130 million and positive free cash flow between $150 million and $200 million. It achieved all four and as a result, it now expects free cash flow of at least $230 million. With this in mind, it will continue its 10 cents quarterly dividend and start repurchasing its shares in 2012. I hope it doesn't and instead implements some sort of special dividend payout at the end of the year. Warren Buffett recently said he would pay no more than 110% of Berkshire Hathaway's (NYSE:BRK.A) book value to repurchase his company's shares. Management is wise to follow his lead. Having said this, it doesn't mean I think Signet's shares are expensive; they're just not cheap.

U.S. Business

One look at Signet's overall business will leave you with two impressions: Its U.S. business is performing marvelously and its U.K. business isn't. Case in point is the nine weeks ended Dec. 31, 2011, which encompass the holiday selling season. Same-store sales in the U.S., which account for 80% of revenue, were up 9.2% compared to a much smaller 1.8% increase in the U.K. For the first 48 weeks of the year, same-store sales in the U.S. were up 11.6% compared to 0.8% in the U.K. Thankfully for shareholders, the bigger piece of the pie is performing as it should. Being a glass half-full type of person, I see this as an opportunity for Signet management.

In the first three quarters of the year through Oct. 29, 2011, its U.K. business produced an operating loss of $2.4 million on $451.4 million in revenue. In the same period in fiscal 2011, it made $1.7 million on $429.7 million. Even then we are talking about an operating margin of less than 1%. The U.S. division, on the other hand, made $287 million on $1.94 billion in revenue with an operating margin of 14.8%. Clearly, the U.K. economy isn't helping, but there's more at work here. The business mix in each country is entirely different. Average sales per store in the U.S. at its Kay stores is $1.7 million, and $4.6 million at its Jared stores. In contrast, its Ernest Jones stores in the U.K. generate $1.6 million while its H. Samuel brings in $1.1 million on average. The big difference isn't so much sales per store as it is the fact the U.S. stores generate 75% of their revenue from diamonds compared to just 28% in the U.K. I'm not a jewelry expert by any means, but I think it's safe to say diamonds are much more profitable than watches and other pieces of jewelry. Therefore, until management can figure out how to increase that percentage in the U.K., business won't improve there. Long-term, however, it is fixable.

Bottom Line

Signet expects $320 million in net income in fiscal 2012 and that's with 20% of its overall business generating a loss. Think how much it could make if the U.K. stores could figure out how to lift operating margins into the mid-single digits. Give it a couple of years and I think it will. In the meantime, the U.S. stores will have to do the moneymaking. Long-term, the geographic diversification will come in handy. Perhaps an Asian or Latin American acquisition makes sense once the U.K. stores are profitable. It will certainly have the cash to do so. Signet's stock in my opinion is reasonably priced. Get on board now as it continues to take market share from Zale (NYSE:ZLC), Tiffany (NYSE:TIF) and others. Its future is sparkles. For related reading, see A Beginner's Guide To Precious Metals.